Only one in four acquisitions succeed in creating shareholder value, says Mr Chris Zook, author of Unstoppable (Harvard Business School Press, May 2007), citing a seven-year study conducted by Bain & Company, a global business and strategy consulting firm.
He gives, as examples, large, "big bang" transforming acquisitions like the one between AOL and Time Warner, and the one by Daimler Benz of Chrysler, which had an exceptionally bad track record, with a success ratio of much less than 10 per cent.
"Certainly, bold deals give a company a sense of power and confidence at the moment of acquisition," adds Mr Zook, in a recent interaction with Business Line over the email. "But the record of eroded balance sheets or tarnished careers is not conducive to either. This is like playing the lottery and calling it your growth strategy."
A graduate in mathematics and economics from Williams College, an M.Phil., in economics from Exeter College, Oxford University, and a Ph.D. from Harvard University, he is also the author of business books such as Beyond the Core: Expand your Market without Abandoning your Roots and Profit from the Core: Growth Strategy in an Era of Turbulence. As a partner in the firm's Amsterdam office and head of the Global Strategy Practice, Mr Zook specialises in helping companies find new sources of profitable growth.
Excerpts from the interview:
What is the recipe for a good acquisition?
The best acquisitions are components of a strategy, not the answer in themselves. First, they are modest in size and used to acquire a capability that strengthens the core. Second, successful acquisitions are usually done by companies that have a repeatable formula; they have successfully integrated and added value in previous acquisitions. Management teams that are new to the game will usually move down a bumpy learning curve. Finally, they are carefully integrated as part of a broader transformation strategy. Cisco, Nike, Novozymes, and UPS are a few examples of companies that have successfully used acquisitions in this way.
Are there early-warning signs of a company's deterioration?
We found three predictive measures that would suggest that a company's fundamental growth formula was in danger, or its value was deteriorating. One sign would be a significant collapse or shift in the industry profit pool - the total profits made in and around your industry by magnitude, sources, and with respect to the cost of capital. For instance, the shift in the photographic industry from analog film to digital imagery actually increased the total worldwide profit pool from about $2 billion in 1995 to about $4 billion ten years later. Yet, only about 5 per cent of that profit pool in 2005 was in film-based photography compared to 100 per cent in 1995. Obviously, this shift disrupts business positions and allows repositioning, which you can see in the range of fortunes from Polaroid (bankrupt) to Kodak (struggling with an 80 per cent market value decline) to Canon (successful transition) to Sandisk (the big winner in memory).
The second indicator is a clear decline in your source of competitive differentiation, replaced or challenged by a new and superior model to serve customers. For example, in 2000, Port of Singapore Authority (PSA) reached a point of crisis. A downturn in global container shipping, combined with high costs and prices, enabled competitors in other ports to attract PSA's largest customers. PSA is now back on track, but only after tearing apart the cost and price umbrella it had built up over the years.
The third place to look for signs of core erosion is when the primary growth formula you have been using starts to reach some natural limit. For instance, a geographic expansion formula that has penetrated the countries, or a strategy to move into successive customer segments that runs out of new segments. Vodafone, for example, was able to grow for fifteen years on the basis of acquisitions and new market entries, before it ran out of countries and reached a point where most consumers in those countries had a cell-phone.
Companies can measure and track all of these three indicators - profit pool, strength of differentiation, and remaining potential of a growth formula. Yet, few do it systematically and fewer have a process aside from the normal annual planning process, to look at these more fundamental issues in the core. We found that 80 per cent of companies feel they are highly differentiated in their core, yet only about 8 per cent of customers agree with that assessment. This perception gap is at the centre of the requirement for self-awareness that is needed to find your next wave of growth, and that is what the book Unstoppable is about. Finding the new growth engine is one of the toughest acts in business.
When is growth on a weak wicket?
Seventy per cent of the growth of any business comes from its history of moving outside of its core into nearby adjacencies like new channels (such as ING the bank creating ING Direct on the Internet) or new segments (like Nike the sport company moving into golf) or new steps in the value chain (like De Beers moving into retailing and branding). However, the odds of success for even these "conservative" and natural moves for the average business are only about one in four. The key to growth is to have a strong core foundation and to find a repeatable expansion formula to push the boundaries of your core out over and over in new areas with a consistent pattern and theme.
Even small bets much farther from the core are fine if a business has a unique opportunity to invest, or sees a distant technology play in which it would like experience, such as some of the investments by defence companies in technologies such as infrared sensing or the investments by traditional pharmaceutical companies in life sciences. The danger comes when companies make those leaps in a way that bets the company with large and risky investments.
What are the forms of `hidden assets' in companies?
Hidden assets come in three major forms, each of which is the collective product of an organisation. One is customer hidden assets like an underexploited brand or a powerful database and deep customer knowledge. The rejuvenation of American Express was built on such a hidden asset. The second is what we call a platform asset, which can be a new business spawned by the core or possibly a support function that has become very strong and has the potential to be a major part of the strategy going forward. IBM Global Services, which began as an ancillary activity and is now at the centre of IBM's core, would be such an example. The third type of hidden asset is a deep and truly distinctive capability. Arguably, the remarkable turnaround of Apple around its music and media strategy (iPod, iTunes, iPhone, etc) is based almost entirely on such deep internal capabilities.
Aren't companies usually aware of their hidden assets?
Companies have hundreds if not thousands of assets, from patents to deep customer databases to unusually strong support and service capabilities (which were the origins of IBM Global Services). Companies are usually aware of these assets, but often are not aware of either their relative strength, their potential as a growth platform, or their true value. This is what we mean by hidden assets.
To illustrate, I start Unstoppable with the example of De Beers, the leader for over 100 years in diamonds. De Beers had a series of hidden assets - brand, customer access, and a database on gem purchase for instance - that it had barely used in its previous core strategy, which had been based on supply control. Its new strategy, based on customer focus and branding diamonds, was built on these somewhat neglected assets. That is a classic example.
But most assets of companies are not true hidden strategic assets, not in the sense of assets with the potential to be the lynchpin of fundamental change. The key is not listing all of the assets, but rather recognising which have that high level strategic potential.
On growth in China and India and what can sustain it.
The developed world has recognised that growth cannot be a monopoly of any country, especially in today's faster, better networked and more global economy. Emerging economies and global innovative players have a disruptive impact in a positive sense; they deliver value to customers and trigger innovation like their global peers.
As companies compete globally, they become more established, but also more complicated, and accumulate customer segments, business platforms, and capabilities whose value they do not immediately recognise.
Chinese and Indian companies will be well on the way to a stronger and more sustainable core, if it is built not just on low-cost labour, but also on investment in business infrastructure and the intellect and talents of their people.
As far as cost advantages go, lower cost competition from China and India is also only one of the forces that lead to increased turbulence and acceleration of the global pace of change.
What are the other forces behind the turbulence?
In our growth research, we have identified six additional key trends as root causes for much of the turbulence in global business today:
Faster movement of information - on everything; Speed of capital formation; Reduced capital intensity among the most profitable new industries; Increasingly rapid movement of executives among companies; The rise and impact of private equity firms; and Speed of overall technology cycles.
How should companies approach these?
No matter where a company is headquartered, the way to take on these forces and differentiate from competitors is to maximise the differentiation in your core: to do what you do best. Achieving market leadership consists of four main patterns: building a high degree of stable customer loyalty, dominating within a distribution channel, building a superior product development engine and building a high market valuation that gives you capital to invest. Costs are simply one element.
To reinvent a company is a new leader necessary?
New thinking is essential. It is difficult to find the right vantage point for looking at a business freshly, especially when a formula has worked well in the past. Some of the best insights about hidden assets come from new CEOs within their first hundred days. But insights into hidden assets can also come from other industries, from outside observers, and from employees who interact with customers and suppliers on a day-to-day basis.
We did find in our data analysis that about two out of three truly successful redefinitions involved a new CEO, or a new management team. Sometimes, like in the case of Harman International, or Apple, or Dell, we have seen the creative founder come back to try to redefine the core after inventing it in the first place.
There is a Chinese Proverb: "To be reborn you first must die." We found many cases of companies that did not die to redefine in the book Unstoppable. Most cases did however benefit from either the pressure of impending crisis, or the fresh eyes of a new CEO. The real trick is how an incumbent team, before crisis, can start the process of redefinition in a smooth way. More and more, I see that self-awareness as the key to success, whether companies are the stage of defining their cores, or whether they have come to a crisis and need to unearth hidden assets for renewal.
Did `Unstoppable' look at the newspaper industry too?
We did not do a specific study of the newspaper industry for the book. But newspapers and media are certainly an excellent example of industries where an accelerating pace of change increases turbulence and causes dramatic shifts in the profit pool. New competitors and Internet-based business models changed the economics of news, such that consumers now have free alternatives to the paid aggregation of content.
Media companies, similar to companies in hardware, software, telecommunications, and many other sectors are finding their core strategy and competitive advantage may no longer be enough for the future. Specific companies and entire industries are confronting the need to redefine, and often still just starting the process of learning how to do so successfully.
On Bain's study.
Bain conducted an exhaustive analysis of the Fortune 500 over the past two decades, comparing the amount of change sought to the amount of change achieved. By defining major change as making significant shifts in the direction of the business, restructuring the portfolio of businesses, being acquired, or going into bankruptcy, we found from 1985 to 1994, 49 per cent of companies experienced major change. From 1995 to 2004, the proportion was 57 per cent.
We combined the analysis of the relative frequency of these change patterns with in-depth case studies, two surveys of approximately global 250 executives, and analysis of the performance of more than two thousand companies that earn over $500 million in annual revenues to arrive at our conclusion.
Our bottom line: in the next decade 75 per cent of businesses, and the management teams in them, will face one of these crises of the core (takeover and integration, financial collapse or bankruptcy, or the need to redefine the core strategy fundamentally). In looking at the literature on strategy and growth, although there are many excellent narrative studies, there are very few based on this amount of data over this long a period of time.
D. MURALI G. RAMESH